Dave Camp Floats a Rewrite of Small Business Tax Rules

Ways and Means Committee Chairman Dave Camp released this week a new discussion draft aimed at simplifying the tax rules regarding pass-through businesses, i.e. those businesses that file under the individual income tax code, such as partnerships, S-corporations, and sole proprietors:

With about half of the private sector workforce employed by a small business – a total of nearly 60 million Americans – every dollar spent on complying with an overly complex, burdensome and broken tax code is a dollar that cannot be used for investment, hiring and higher wages for American workers. The discussion draft contains several core components that simplify tax compliance for small businesses and provide certainty with respect to the ability of small businesses to recover certain costs immediately. These include widely supported reforms such as permanent section 179 expensing and expansion of the “cash accounting” method, amongst other provisions. The discussion draft also includes two separate options designed to achieve greater uniformity between S corporations and partnerships – one that revises current rules and a second that replaces current tax rules with a new unified pass-through regime.

Compliance with the income tax is a serious problem, and especially difficult for small businesses. Dave Camp deserves much credit for shining a light on this problem, which disproportionately affects those taxpayers least likely to have much of a voice in Washington, i.e. entrepreneurs and other upstart businesses. Most of us do not run businesses or file business tax returns, so it would surprise most Americans to know the ridiculous time-wasting hurdles the tax code forces upon business. Strangest of all is the requirement that legitimate business expenses be written off over a period of years or even decades. This is what passes for “normal” cost recovery, only because we have been stuck with it for so long. Various reforms over the years have exempted certain businesses from these rules, such as section 179 that exempts small businesses. But it begs the question: why do we continue to mistreat medium and large businesses this way?

For a taste of just how silly the tax code is in this regard, here is Forbes writer Tony Nitti on section 263A:

There’s nary a tax advisor alive who wouldn’t like to see Section 263A – which requires a producer or reseller to capitalize a portion of their G&A costs into their ending inventory – struck from the Code. The regulations are exceedingly complicated and impractical to implement, and rarely will a client be willing to pay an advisor the amount it would actually cost the advisor to compute the capitalized costs correctly.

While Camp’s proposal doesn’t go as far as to remove Section 263A from the law, it does greatly expand the universe of taxpayers who will be exempt from the provision.

Under current law, resellers with less than $10,000,000 of average gross receipts are exempt from Section 263A; producers, however, are subject to the capitalization requirement regardless of their level of receipts. The proposed legislation would expand the $10,000,000 exclusion to cover producers as well, relieving a great many small businesses from the need to undergo this time-intensive computation.

Again, why do we do this to any business? Dave Camp rightly wants to simplify the code and treat businesses more equally, but the first step in that process should be to abandon the distinction between small and big business, which is never well defined anyway. Ultimately, all businesses should be taxed under the same simple rules. The biggest impediment to that in the code is the treatment of cost recovery, which depends not only on the size of the business, but the industry. It may be hard to believe, but the same machine used by the transportation industry is treated differently for tax purposes when used by the retail industry. The tax code contains some 4000 different classifications of business assets, depending on how they are used and by whom. This is ridiculous.

The end result is that businesses are reluctant to invest, since they are allowed to deduct only a portion of their investments immediately and the rest over a period of years or decades, depending on rules that never made sense.

Let’s hope the next discussion draft acknowledges that a) all American businesses should operate under the same rules, including tax rules, and b) if we intend to tax business income it should be defined as simply as possible and neutrally for all businesses. The logical way to get there is to first let all businesses use cash accounting and to deduct immediately all investment expenses, i.e. the same way labor expenses are treated now. Such a move would not only make life simpler for millions of small and large businesses, but it would boost investment dramatically, leading to more productivity, higher wages, and more jobs.

Follow William McBride on Twitter @EconoWill